Fighting the Franc
Today's news headlines:
- ‘Hong Kong leader urges calm as protest tensions rise; airport reopens’. Hong Kong leader, Carrie Lam, said that violence by protesters had pushed the region into a ‘state of panic and chaos’ but vowed to rebuild the economy after tensions settle. Demonstrators are part of a pro-democracy movement fighting for the erosion of the ‘one country, two systems’ arrangement, but in recent days ‘sprouts of terrorism’ have emerged according to Beijing. (Reuters)
- ‘Argentine assets hit after Macri stumbles in primary vote’. Populist candidate Alberto Fernandez’s win in primary elections caused Argentina’s currency to fall as much as 25% and the Merval stock index to lose 37% in Dollar terms. Speculation is mounting that President Mauricio Macri will lose October’s election after his programme of austerity caused a deep recession, high unemployment, and inflation of more than 50%. (Financial Times)
The flight to safety
For a while now we’ve seen global growth sentiment sour, mostly caused by the US-China trade war, but also due to the ongoing Brexit crisis and geopolitical troubles in a plethora of emerging market economies. This incentivised market participants to look towards safer assets like gold, the Japanese Yen, and all manner of sovereign debt. Looking back to November 2018, you could receive a yield of 3.2% on the US 10-Year Treasury Note and a troy ounce of gold would only set you back around 1,200 USD. Fast forward to today, and gold has appreciated more than 27.5% to around 1,500 USD per ounce, while the US 10-year yield is over 50% lower! These are just two particularly telling measures, but we’ve certainly seen investors pile into government bonds across the board.
Yesterday, the US 30-year yield slipped toward all-time lows as negative stories from Hong Kong and Argentina dominated the day’s proceedings. APAC wasn’t spared as Australia’s 10-year bond yield opened at a fresh all-time low and Japan’s 30-year yield dropped to its lowest since July 2016. Forgetting geopolitics, market expectations of future US interest rate cuts have also acted as a catalyst for the flight to longer-dated Treasuries, with the possibility rising that US rates could eventually turn negative. We’ve seen a continued fall in global interest-rates, and this has prompted US Fed funds futures to price in between two and three more 25bps cuts for the rest of the year.
Bottom line: In recent days, the continued flight to safety has seen most of the G-10 currencies remain relatively range-bound with little intra-day volatility. Despite little progress in the trade war, appetite for the Dollar has remained as it sits in the upper segment of its one-year range.
Drastic times, drastic measures
The Swiss National Bank (SNB) is fighting against an appreciating Franc and may not have enough ammunition to curb the unfavourable trend in a slowing global economy. So far this year, the Swiss Franc has appreciated 4.0% against the Euro, despite Switzerland having the world’s lowest interest rate at -0.75%; the SNB’s ability to control the currency looks weak. Recently, signs have emerged that the SNB has taken alternative action since its ‘sight deposits’—deposits that commercial banks hold with the central bank—jumped the most in two years. This suggests the SNB actively intervened to weaken the Franc.
The European Central Bank (ECB) is expected to cut its interest rate next month to support a weakening Eurozone which is likely to exacerbate the SNB’s currency problem. However, SNB President Thomas Jordan claims there is enough room to manoeuvre through interventions and interest rates, despite already having negative interest rates. You shouldn’t discount dramatic action too much when it comes to the SNB—in 2015 policymakers removed the cap against the Euro, sending the Franc 30% higher.
Bottom line: The issue for the SNB will be whether it can control the currency over the longer term and how the currency’s appreciation affects the domestic economy, particularly inflation, which is marginally above zero. The SNB’s situation has been used as a prime case study for the debate over the effectiveness of the unconventional monetary policy. Now that the global economy is under stress, drastic policy action may be needed to achieve economic stability.
In yesterday’s session, the pair tested 1.21 but failed to break through the resistance level. This morning, the pair heads back lower and may test previous support of 1.2015, especially if this morning’s UK’s labour market data disappoints. The recent trend of Dollar strength and Sterling weakness certainly looks set continue.
Yesterday morning, the pair reached 1.0724—the lowest level in over a decade—before rebounding back towards 1.08 in London trading. Today, both European and UK data out may be a short-term driver of the pair. Although with the Euro Index finding support at the 200-daily moving average in recent sessions, Euro weakness may be limited.
Following the Euro rally at the beginning of the month, the pair has hovered around the 1.12 handle. After a brief deviation lower in yesterday’s session, the pair has since climbed back towards the big figure. Germany’s ZEW Survey on economic sentiment out this morning may be a short-term driver of the pair over the course of today’s session.